Interest Rates: Tough Days Ahead
The stockmarket’s initial reaction to the much-awaited pause in US interest rate hikes has been very cautious. There is a bit of disappointment that the Fed has declined to call an end to the tightening cycle.
That means that if the data warrants, the Fed may well hike rates at its September 20 meeting. For traders, that spells more uncertainty.
There is also the fear that slowing growth will hurt earnings and the doomsayers are now predicting the return of stagflation — a deadly cocktail of low growth and high inflation that was the characteristic of the 1970s.
Stepping back and looking at the big picture may help clarify matters. Gavekal, a well-known if unorthodox independent research outfit, has a rather interesting take on inflation.
In a recent article, Gavekal’s Louis-Vincent Gave argues that the current global economy is based on a system where China gets the jobs while America (and other Western nations) gets the profits. Gave argues that this results in the rich becoming richer as shareholders in Western companies make money hand over fist.
In turn, this results in “discontinuous inflation” where the prices of goods made in countries like China fall, while the prices of commodities that China doesn’t have enough of (for example, oil) rise in price. At the same time, because of the increase in money supply, prices of non-tradeables (haircuts, housing, healthcare, etc.) also rise. Gave says “ever-cheaper consumer goods from China have created more leeway for other prices in the world economy to go up.” Gave goes on to say that one consequence is that countries like the UK, which mainly provide services, grow richer.
Gavekal concludes that inflation is not really a threat because it is the product of earlier years’ easy money policies and rising Chinese export prices. Both these factors are now in the past.
What does Gavekal’s analysis mean for the markets? It implies that the US Fed has no reason to tighten rates further and even if it does, it will soon reverse its policies. It also implies that investing in the services sector is a better bet than investing in manufacturing.
Two points can be made out of this. First, won’t outsourcing of services have the same impact as outsourcing of manufacturing? Second, shorn of all the theory, the investment implications boil down to that old market saying: buy what China buys, sell what she sells.
